An income statement (also commonly known as a profit and loss [P&L] or earnings statement), answers a very important question: Is your company profitable? The accuracy of your P&L is critical to ensuring your business is running as efficiently as it could be and to identify opportunities for increasing revenue and/or decreasing costs.
While having an accounting expert on your side is wise to ensure this document is being created accurately, understanding how to interpret income statements oneself is a useful skill for business owners.
Today’s post will provide an overview of what an income statement is and how that data can be utilized to make business decisions.
WHAT IS AN INCOME STATEMENT?
A P&L is most commonly generated monthly, quarterly, and annually, and it provides a working picture of a business’ revenue, expenses, and net income over those periods of time.
At the report’s bottom line, one can see if the company has made a profit, and compare the profit amount with that of previous time periods. This makes the report valuable to lenders, investors, and shareholders in addition to business owners.
You will always see breakdowns for 1) revenue and gains and 2) expenses and losses from primary (i.e., operating) activities and secondary (i.e., non-operating) activities. The primary activities portion discloses information about revenues and expenses that are a direct result of regular business operations, like selling your standard goods or services.
HOW TO USE AN INCOME STATEMENT TO MAKE SMARTER BUSINESS DECISIONS
As with any financial statement or business data you have, it’s only as good as what you do with it and income statements are no different. There is a multitude of ways that your income statement can determine areas and opportunities for growth and change. Here are a few of the most common ones:
- Deciding whether to hire or downsize
- Determining which growth opportunities to focus on
- Uncovering which products or services are generating or losing you money
- Deciding where to cut operational costs
- Reevaluating your pricing strategy
- Negotiating during a merger, acquisition, or sale of your business
HOW TO UTILIZE YOUR INCOME STATEMENT
The P&L is primarily focused on examining the actual operating efficiency of your company by assessing profit margins. Let’s start by defining margin: Gross margin indicates the core profitability of your company. It calculates basic profit levels based on revenue less direct expenses, before any indirect costs. It, therefore, helps in determining the financial success of particular products and services. Net margin, on the other hand, calculates the profit that remains after all expenses, including interest and taxes, have been deducted from your revenue.
You can benchmark your margins against other companies in your industry, or past performance of your own company, to gain insight into which portions of your company are over- or underperforming. This can help you to invest in what will grow your business and address any elements that need improvement. You’ll also need your P&L for tax preparation and loan applications, and your financial advisors will need it to make recommendations for your business.
Understanding income statements is a key part of running your business efficiently and effectively. They not only reveal the health of your income, assets, and associated expenses—they also give you much-needed context for how those change over time. And it all starts with getting an accurate, up-to-date P&L from your accounting partner when you need it.